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"Little Musings"
View: Spain ‘worries’ totally predictable, PM Rajoy’s delaying tactics all part of the game
Watching the Eurozone crisis unfold is a bit like sitting down to watch a few Road Runner cartoons, we all know Wylie Coyote is going to run over a cliff at some point we just don’t know what sort of pain and suffering he’ll go through first and the particular shape he’ll form when he hits the bottom. In these terms one could well compare the market to a four year old, deriving endless surprise, dare we say enjoyment, from what is a tried and tested formula. And so we find ourselves with panicked headlines from Spain once again with the usual media tarts rolled out with a new damning indictment on why the project is doomed, a scenario as predictable as any of those classic cartoons.
Full report below…
View: A Greek exit would be the perfect test case for the remaining PIIGS
The double whammy of the election of a French socialist President and anti-austerity parties sweeping out the incumbent coalition in the Greek parliamentary polls are both clear negatives, occurring at a time when the region’s real economy in already heading back to recession. While the implications of the French election are by no means insignificant, they are something that will take shape over a slightly longer timeframe. Furthermore there are still legislative elections to come on June 10/17 which means the division between campaign words and governing actions will remain somewhat elevated. So we’ll leave that at that for now and move to the faster moving situation back in the birthplace of the crisis, Greece, which has more direct market implications.
Full report below…
View: Germany’s selective historical memory needs jogging, not just for the Greeks
Despite our more constructive ideas about a Greek bailout, it seems the political tide is shifting with the default view gaining traction again in markets. As ever it appears to be driven by German machinations, refusing to lift that boot of the Greek neck despite the government pushing amended legislation through parliament on Sunday night and New Democracy leader Samaras appearing to have finally put pen to paper to honour the promise to continue with this path after elections. The wires are awash with rumour and counter rumour as to whether the Eurogroup will cut the Greek’s loose with the latest leak suggesting that officials were considering proposals to delay some of all of the bailout but still avoid default is the latest low. Sounds a neat trick.
Full reports below
We have maintained for two years that Obama’s regulations and the threat of even more are the primary retardants to US job growth. This is an inconvenient fact for the left, but a fact nevertheless. It is not our conjecture; we have it directly from CEO’s.
George Will brings the example of Carl’s Jr restaurants to mind in a recent piece.
Writes Will, “In 1941, Carl Karcher was a 24-year-old truck driver for a bakery. Impressed by the large numbers of buns he was delivering, he scrounged up $326 to buy a hot dog cart across from a Goodyear plant. And the war came. So did millions of defense industry workers and their cars. And, soon, Southern California’s contribution to American cuisine — fast food. Including, eventually, hundreds of Carl’s Jr. restaurants. Karcher died in 2008, but his legacy, CKE Restaurants, survives. It would thrive, says CEO Andy Puzder, but for government’s comprehensive campaign against job creation.”
Will continues, “When CKE’s health-care advisers, citing Obamacare’s complexities, opacities and uncertainties, said that it would add between $7.3 million and $35.1 million to the company’s $12 million health-care costs in 2010, Puzder said: I need a number I can plan with. They guessed $18 million — twice what CKE spent last year building new restaurants. Obamacare must mean fewer restaurants.”
But for all but the willfully blind, this is no surprise.
Finally from Will, “In an economic climate of increasing uncertainties, Puzder says, one certainty is that many businesses now marginally profitable will disappear when Obamacare causes that margin to disappear. A second certainty is that ‘employers everywhere will be looking to reduce labor content in their business models as Obamacare makes employees unambiguously more expensive’”
Let us look to the Nov/12 election for an end to this nonsense.
Suddenly the media is loaded with commentary regarding an end to China’s miracle if she does not discard the evils of central planning.
These authors are correct.
We stated that there would be no so-called “hard landing” in China (with growth at 9%, we suppose a hard landing there would be a welcome event anywhere else). In fact, we have highlighted the Chinese consumer as one locomotive to a world recovery.
The reason for that optimism is that we know that central planning can appear to work, up front. For example, it is well known that authorities deliberately deflated the property bubble by forcing lenders to cut back loans to developers. And we saw that the central bank acted reasonably with only modest lifts to combat inflation.
Yet however reassuring these things may be, the time frame is limited, short to intermediate term, within our normal window; that to which most desk trading decisions are confined.
Centrally planned economies sometimes thrive early on because central planners pump resources into sectors where market demand is nonexistent (in China, this may mean targeting the interior provinces next). As a result, these economies avoid recessions for a bit; yet it is a phony fix. Eventually, as the Soviets learned, the mis-allocation of capital results in an ultimate tanking of the economy. And there will always and everywhere be mis-allocation of capital in a planned economy. Real prosperity is spawned only by economic and civil liberty; that is, the rule of law.
Thus, if we are to venture past our normal time frame we would say that China is doomed if she continues to favor bureaucratic planning decisions over the unseen hand. It won’t work. China’s absurd home purchase restrictions – controlling the number of homes each family can buy, whether they can afford it or not – is a perfect case at point.
In conclusion, we will look for near-to-intermediate term resilience from this credit but her life span is limited and her economy will implode unless adoption of free-market principles become not partial and cloaked by party jargon, but wholesale and transparent. If it is political change which precedes economic change, we may be hopeful. But it may take a new generation for this to happen, and it may be too late.
View: ECB must step up to the plate to stabilise crisis
Prospects for technocrat governments in Italy and Greece seem to have created a glimmer of hope, a rather curios reaction given the multitude at problems facing the new leadership in these troubled periphery states. While the exit of Berlusconi certainly warrants feelings of euphoria – rarely do democracies have to suffer from such morally corrupt leadership for so long – the exit of Greece’s Papandreou doesn’t really shift the balance, after all he was something of a technocrat figure anyway. Replacing him with a slightly better qualified one won’t have a marked effect on the country’s long-term fate (death by debt trap). Similarly the problems facing Italy goes far beyond a delusional leader, politics is likely to remain fractured and the economy is already heading towards recession; further steps to tighten fiscal policy will merely reinforce these pressures and erode confidence á la Portugal and Greece. Italy is no Ireland.
Recent bond market price action confirms this. The overshoot in Italian yields last week may have been triggered by LCH Clearnet raising its margin requirements but the mild recovery since, aside from patches of short covering, has been a function of defensive and sometimes aggressive ECB buying rather than any vote of confidence in a new government and optimism the administration will be able to take meaningful reform measures. Real investors continue to vote with their feet, unwilling to give Italy the benefit of doubt, having already suffered ignominy in Greece where they are now being asked to take a ‘voluntary’ 50% haircut (which will no doubt rise at the next bailout) vs. a zero write down for official lenders. Such balance is unworkable longer-term in our view and certainly based on projections that leave Greece’s debt to GDP ratio at 120% after restructuring and the austerity programme.
Contagion to Germany’s AAA rated peers is equally noteworthy. France in particular is in the firing line with the quickly revoked ‘downgrade’ from S&P’s (we’re not quite sure what type of technical issue not only send out a downgrade but also writes the covering letter) seen by many as merely the shape of things to come. Looking at spreads to bunds France’s AAA charade has already gone, trading at 175bps over 10-year German paper (and that’s 15bps tighter this morning thanks to the ECB) still some 29bps wider than when we recommended selling France back on Nov 9th (http://wp.me/p1G1Fr-j3). While ECB activity will keep things volatile the path of least resistance is clear. Earlier victim Spain is also back in the firing line with penal levels of unemployment making austerity all the more difficult to enact and growth flat-lining even before the latest flare up. Elections later this month add a further mist to proceedings.
We’re inclined to pin the blame on this spread on the German’s. Not only do they remain rigorously committed to the one dimensional austerity driven solution, which simply can’t work in Greece and given the Italian economic trajectory is an equally dangerous endeavour there, but are also remain vehemently opposed to allowing the ECB to cushion the blow by becoming the lender of last resort. Such hostility to ECB money printing may have its roots in the hyperinflation of the Weimar Republic (and we all know where that led) but economic conditions are somewhat different in 2011 to the 1920’s and there is also ‘form’ as to how such monetisation might impact thanks to quantitative easing programme enacted in the US and UK. To suggest that by allowing the ECB a broader mandate could lead to a similar outcome is simply disingenuous. Of course the German’s still do not see it this way. Nor do they appear (or want) to understand the difficult in enacting round after round of aggressive austerity in the countries in the firing line. It’s always easier to prescribe than administer.
A good dose of pragmatism is needed, growth is vital to stabilise debt dynamics which appears to have been largely overlooked when conjuring up the bailout programmes. Austerity may have a similar impact on a multi-year (decade) timeframe and avoid the moral hazard element that is proving so hard to sell to core electorates, but it is unrealistic to think markets will be willing to move on with a solution that leaves the periphery in a quasi-depression –it will simply lead to more contagion. Nor do we believe countries affected will have pain thresholds high enough to tolerate such narrowly focused solutions. In fact the most likely consequence of technocrats administering German medicine is that it fractures whatever flimsy consensus remains, significantly increasing the chance of a disorderly end to euro membership for some states or even the death of the entire project.
With realistic compromises there is still room to put in place structures to end financing pressures, speed up structural reform and ease pain of austerity and therefore downside risks to growth (or recession!). Reforms need to be focused at a structural level rather than on immediate slash and burn budget consolidation. Measures including raising retirement ages, means testing entitlements and reducing red tape for business would all provide significant medium-term benefits. Tax reform should also feature heavily. A weaker euro also has a critical role to play in helping temper the pain of adjustment (see our note of November 9th http://wp.me/p1G1Fr-jd). Most importantly now though is the influence of the ECB. It is the only institution that has the resources to provide the necessary liquidity, enabling it to retake the initiative lost to markets. Despite its protestations this might actually already be happening, by being forced into aggressive purchases of Italian debt (which the new Monti government will at least ensure it continues to do) the ECB will find it increasingly difficult to sterilise its interventions. It had hoped it would be let off the hook as an enlarged EFSF came on line but plans to leverage this fund have unravelled as quickly as they were announced and the EUR1trn size muted is still insufficient. This leaves the ECB with little option but to reluctantly purchase debt of those struggling to fund in the market.
It would be ironic if Europe blindly walked into a solution having walked into so many traps eyes wide open.
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View: Is a Greek bank run top of the ‘what happens next’ list?
Shy of a miracle it’s difficult to see how the fallout from Greece PM Georgios Papandreou’s referendum pledge can be contained. Even if his own party opt to eject him to try and limit collateral damage or he falls in the looming confidence vote he has also promised it will be difficult to put a genie like this back in the bottle. The ruling PASOK government has offered this to the public and we’d imagine there would be a marked reaction if this was stolen back. The damage has been done.
The key question should now be where this leads to in the short-term. Markets are fretting over a government collapse and what this means for the recently agreed bailout, given the vocal criticism of the PM within PASOK today this looks a viable outcome. Equally relevant is how this development impacts the broader EU debt crisis solution; would a disorderly Greek default wipe out the flimsy firewall the EFSF provides for Italy at al., even the new improved version? But there are more immediate risks in our mind at the local level that the market does not appear to be considering yet, namely the prospect of an old school (perhaps not that old remembering Northern Rock) run on the banks.
Local deposits have been eroding at pace for many months (there are plenty of stories of Greek cash buyers in the London housing market trying to protect their cash assets) but faced with years of even more intensive austerity and thereafter a still unworkable debt burden (120% of GDP if the new bailout is to be believed) this pace can only increase. The flip side now appears to be a ‘no’ vote and effective bankruptcy, not to mention the obvious implications that would have for Euro membership., one would have to be deluded to keep any sizeable deposits in local banks, no matter how strong one’s sense of national pride or fondness for the drachma might be.
In fact sending money offshore offers depositors sizeable upside and zero downside. Such a scenario however would only reward those with first mover advantage, solvency would quickly evaporate and take Greece to its pain threshold far more rapidly than any political evolution. This would inevitably force the ECB into the hot seat but whether active intervention from Frankfurt would be enough to halt the snowball is a question we’d rather not see tested.
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- Greek Referendum Is On (zerohedge.com)
- THE BIGGEST BOMBSHELL OF ALL: Greek PM Papandreou Has Gone Rogue (businessinsider.com)
Market pundits continue to discuss the recent S&P’s downgrade which saw the US finally lose its treasured AAA status (now AA+ with a negative outlook). Things seem to be fairly evenly divided in the debate over whether it was the correct decision; Warren Buffet responding with his ‘the US should be AAAA’ remark while Pimco among others have praised the agency for its boldness in an addressing the structural issues at the heart of the deficit problem. Congress in contrast is keen to drag the agency over the coals for its heretical move, centring on the initial USD2tillion error that appeared in the agencies calculation.
Much of the discussions have centred on the fiscal debate and how the spending/revenue mix needs to change to check the surge we’ve seen in the debt/GDP ratio, ironic if you look at the CBO’s June 2011 projections for public held government debt. Indeed, even under the baseline scenario the debt burden is envisaged to merely stabilise at around 75% of GDP over the next decade vs. sub 40% pre financial crisis. This looks wildly optimistic given the assumptions involved such as the 5ppts increase in the tax take as a % of GDP by 2015 as well as a substantial paring back of health/social security obligations. The alternative baseline scenario is much more realistic given current hostility to increases in taxation and the baby boomer effect on entitlement programmes. Under this forecast debt levels would instead hit 100% of GDP over the next decade and continue upward thereafter, crossing the 200% marker in the late 2030’s. That’s not really the stuff AAA ratings are made of.
Not that this is actually that relevant for the US, after all ratings hold far less sway for sovereigns that exclusively issue currency they can create at will – particularly when one has the enviable position of printing the world’s premier reserve currency. Such tactics have been used for millennia; debasement started with governments reducing the silver/gold content of coinage, usually in response to some overambitious military foray (oh, how times change). The Romans were particularly adept at this as were the medieval battling monarchies of Europe. This is really the key issue and something investors more often than not overlook. Trying to quantify repayment based on the simplistic terms of S&P’s risk of default model misses this point. Debt can always be repaid in nominal terms if the State is willing to debase, either crudely by printing or more subtly by keeping real rates in negative territory – as was seen post WW2 in many countries. In this respect US Treasuries should still trade like a AAA asset even if the nominal isn’t worth that much when it’s returned, stresses should instead continue to appear in the dollar. A more poignant question perhaps is why a AAA rating is still considered a risk free benchmark in the first place. If investors begin to fret over this UST’s will wobble.
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